The process of negotiating the sale or acquisition of a private company should be a simple process, right? But most often, it is not. There are numerous parties involved at the negotiating table and behind the scenes of a transaction. There is the possibility of 17 or more parties that want to win -- for themselves and their stakeholders -- in negotiating the deal.
The parties involved may include:
On the Seller’s side—the owners and possibly their spouses, the M&A advisor, seller’s attorneys, key employees and their own attorneys and CPAs.
On the Buyer’s side—the buyer(s) and possibly their spouses, the M&A advisor, attorneys, CPA, due diligence team, valuation firm, real estate appraiser, as well as each funding source, their funding officer, and their attorney.
The buyers and sellers both have millions of dollars at stake, and they can become very emotional during the negotiation process. They should try to respect each other and remain friendly. Buffering provided by experienced advisors will help. An adversarial relationship is not productive and is unlikely to result in a closing. Each side is spending tens of thousands of dollars in professional fees whether they close or not, so a closing is the desired outcome. Early negotiations start when the buyer and seller begin to learn about each other, first with conference calls, then face-to-face meetings.
Most transactions over a $1 million don’t have an asking price, because the value of the business is ever-changing as the business grows. Plus, every buyer has a different opinion as to the value of the business, and what assets and liabilities should be included. A letter of intent (LOI) is usually the first negotiating document that buyers and sellers develop with their advisors.
The price and terms are the big ticket items to negotiate. Price and terms include the total amount of the sale, how much cash at closing, seller notes and terms, earn-outs, working capital amounts, assets and liabilities included, and employment agreements.
During due diligence, the buyer’s investigating team seeks to confirm information that has been given to them, but is also looking for inaccuracies not previously disclosed, or hidden gems or opportunities that haven’t been presented. Much of their investigation has to do with the financials, to confirm revenues and expenses, but they can also explore customer and supplier details, inventories, fixed assets, competitor analysis, legal, etc. Once the due diligence team finishes, the LOI could be renegotiated depending on what they found.
Which side writes the initial purchase contract: the buyer’s attorney or the seller’s attorney? Often each side prefers to write the initial draft. There are dozens of key issues in which each side wants protection and will negotiate. These include representations and warranties, defining financial statement accuracies, materiality provisions, undisclosed liabilities, conditions to closing, post-closing purchase price adjustments, indemnifications, survival time to assert claims, carve outs, types of damages, baskets-deductibles, thresholds, caps, escrows/holdbacks, setoffs, remedies, governing law, venue, ADR, tail insurance, etc.
Negotiating the purchase price allocation has different tax ramifications for each side. The buyer and their CPA will want to get quicker write-offs, so they will want to allocate larger amounts to equipment, vehicles, other fixed assets and consulting agreements. The seller will want to minimize their taxes and get capital gain tax treatment, and have larger amounts allocated to goodwill.
The seller typically has more of an emotional-based agenda. This is their baby and they may be selling because of retirement or burnout. But they don’t have to sell and they won’t make the same amount of money in the stock market. Sellers usually feel they are not getting fully paid for their countless hours of starting the business and the risks they had to take. The seller needs a certain amount of money after taxes to walk away, and they want to make sure their people are taken care of. A buyer should be sensitive to the seller’s emotions.
The buyer also has emotions that the seller needs to be aware of. The buyer will be borrowing a great deal of money and most likely personally guaranteeing the loan, perhaps along with their spouse. The business can only support so much debt. The buyer needs to be able to pay themselves a workable wage and provide a reasonable ROI.
Knowledge is power. The greater your M&A knowledge, the greater your power, and the more successful you will be in selling. Knowing why a buyer is interested in the selling company may help in the negotiations. Knowing what other companies the buyer has acquired is also helpful. A seller and their advisors have a great deal of power in negotiations if they have multiple buyers interested in the business. And the opposite of that is true, too. The buyer has more power if they are the only ones involved in seriously looking at the business and the seller is motivated to sell.
Experienced advisors with transactions are vital. Having an M&A firm and M&A attorney with the knowledge and experience in dealing with numerous sales and acquisitions will generate a much better price, terms, and management of risk for their respective side. And when one side doesn’t spend the money to hire proper advisors, they could suffer greatly.
There is a finite amount of energy in every transaction. Deals sometimes fall apart because one side runs out of gas. Do not assume that the other side will keep going back and forth for an unlimited amount of time. The buyer shouldn’t be trying to steal the business and the seller shouldn’t induce the buyer to excessively overpay. All parties should negotiate to a win/win, or there may never be a closing.
If O’Keeffe & O’Malley can help you in negotiating all or part of your transaction, please call us at 913.648.0185.